When you walk into any car dealership in the U.S., it may seem the salespeople are speaking a foreign language. The unfamiliar terminology is one of the things that makes buying a car so stressful for many people, so we are providing the following glossary to prepare you car shoppers for some of the terminology you will face at the dealership.
Annual Percentage Rate (APR): Also called a finance rate, this is the interest rate on a loan; a percentage of the amount borrowed that a lender charges annually for the use of its money.
Acquisition Fee: A fee charged by the dealer for initiating a lease; ostensibly covers the costs of processing the lease—credit reports and insurance verification, for example—but is in actuality pure profit. Although many fees associated with a lease are negotiable, this one is generally unavoidable.
Balloon Payment/Balloon Loan: A loan that pays off only a portion of a vehicle during its term and demands a large sum—the “balloon”—to be paid at the end of the loan.
Bump: The difference between the rate a dealer pays for financing on a loan or a lease (called the Buy Rate) and the rate at which they sell the financing to you (the Sell Rate)—typically around one percent. Dealers generally don't disclose this bump, so do your homework on the actual rate being offered by the manufacturer or finance company and negotiate to reduce or eliminate the bump. Also known as a Spread.
Buy Rate: The rate at which a car dealer acquires financing. The dealer can profit by offering the financing to a consumer at a higher cost (Sell Rate) and keeping the difference (Spread).
Buyout Price: The price of buying a car at the end of the lease term. If you think you might buy your vehicle at the end of the lease, carefully compare the costs of buying outright to those of purchasing after a lease. A high residual/high money factor lease may yield an attractive payment, but it makes for a bad deal if you buy the car at the end. A low residual/low money factor lease can yield a similar monthly payment during the lease and allow a better deal for buyers at lease-end. Sadly, the former is still the more typical offering.
(Net) Capitalized Cost: A leasing term that means the sum total being financed through the lease—vehicle price plus any extras and minus the capitalized cost reduction. Also known as "Adjusted Cap Cost."
Capitalized Cost Reduction: Anything—down payment, a trade-in—that reduces the amount financed through a lease.
Closed-End Lease: A lease that gives the lessee the option of either buying the car at the end of the term at a set price or walking away without liability for any unexpected reductions in the vehicle's value (other than those resulting from damage or modifications). Closed-end leases are what nearly all car companies and banks offer, but it is smart to verify that your lease is closed-end. Also known as a “walk-away lease.”
Cost of Funds: An APR, a money factor, or a rent charge, this is the charge for using the bank’s—or another lender’s—money to acquire the car. Also known as financing costs.
Dealer Holdback: A small percentage of a vehicle’s cost that a manufacturer pays back to a dealership after the vehicle has been sold. This is what allows dealerships to sell vehicles at invoice price or below and still make a profit.
Dealer Incentives: Special offers from car manufacturers to their dealers—which are usually passed on to the customer—to encourage sales in a slow market or when excess inventory builds up.
Dealer Invoice: The amount a manufacturer charges its dealers for a car.
Dealer Prep Fees: Charges—usually negotiable—added to the purchase price of a new car to cover the cost of preparing the car for sale after its transport to the dealership.
Default: Failure to make payments or otherwise abide by the terms of a financing contract.
Destination Charge: The amount charged for transporting new cars from the factory to the dealership. The destination charge on the dealer invoice is not negotiable, but you should never pay any added destination charge tacked on by a dealer, unless you've requested and agreed to such a charge for a vehicle that must be transported a long distance from another dealer.
Disposition Fee: Also known as a termination fee, this is a fee charged by finance companies at the close of a lease to cover the cost of bringing the car back into its fleet and prepping it for sale again. This is often waived if you buy another car from the same brand at lease end.
Documentation Fee: Charges intended to cover the cost of processing the paperwork involved in the sale of a car. Many fees charged by dealers are negotiable, and this one should be challenged as extraneous if it's more than $100.
Down Payment: Cash paid up-front by a borrower to reduce the amount financed in a lease or loan. While a large down payment can reduce your monthly payments, it also likely will be forfeited in the event of a totaled or stolen vehicle.
Early Termination Fees: Penalties paid for withdrawing from a lease or loan ahead of the scheduled end date. Typically these penalties are very large—akin to simply paying off all remaining payments without the use of the car. These may apply if a vehicle is stolen or totaled and you don't have gap insurance.
Equity Lease: A rare kind of lease in which the lessee must buy the vehicle at the end of the lease. See Open-End Lease for more detail.
Excess-Mileage Charges: Penalties paid at the close of a lease if the lessee drives the vehicle a greater distance than the limit stipulated in the contract. It's always cheaper to buy the excess miles at the beginning of the lease, so it's best to be realistic about your likely mileage needs.
Excess-Wear Charge: Penalties paid at the close of a lease if the car is returned in poor condition. Be aware that these charges can be levied for modifications such as tinted windows, different wheels, or anything else that could be construed as lowering the value of the car.
Extended Warranty: Also known as a “service contract,” it is an agreement to cover certain specific service and repairs beyond the life of the factory warranty. Except for those offered by manufacturers directly, most either cover so little as to be useless or are outright scams.
Fair Market Value: Used only in rare open-ended leases, this is the worth of a leased vehicle at the end of the lease period.
Financing Costs: An APR, a money factor, or a rent charge, this is the charge for using the bank’s—or another lender’s—money to lease the car. Also known as cost of funds.
Finance Rate: Also called an “annual percentage rate”; the interest rate on a loan. A percentage of the amount borrowed that a lender charges annually for the use of its money.
Fixed (Guaranteed) Residual: A price—decided upon at the initiation of the lease—at which a lessor promises to sell a leased vehicle to the lessee at the close of the lease. Can work in the buyer’s favor if the value of the vehicle is greater than the predetermined price, but the opposite is more likely to be true.
Gap Insurance: Insurance that covers the difference between a vehicle’s depreciated value in a loan or a lease and the amount owed on it in case it is stolen or totaled, a difference the owner or lessee would otherwise have to pay the lessor.
Lease: Essentially a long-term rental in which the dealer (or a third-party buyer working with the dealer) buys a car and allows the lessee to use it for a specific period of time or agreed mileage while making monthly payments. At the end of the lease period, the lessee can either buy the car or return it to the dealer, depending on the type of lease.
Lease Extension: An agreement between the lessee and the lessor to continue the lease beyond the initial term, generally without altering the monthly payment.
Lease Payment: The amount you must pay every month during the term of a lease. This is the sum of the Rent Charge and the depreciation charge plus applicable taxes. Your monthly depreciation charge is calculated by taking the difference between the Net Capitalized Cost and Residual Value and dividing by the Term in months.
Your monthly Rent Charge is calculated by taking the sum (yes, really the sum) of the Net Capitalized Cost and the Residual Value and multiplying it by the Money Factor. This sounds counter-intuitive until you think of it this way: You're actually taking the average of the Net Cap Cost and the Residual Value (about what you owe halfway through the lease) and multiplying that number by the effective annual percentage rate, then dividing by 12 to get a monthly amount.
Lessee: The person leasing a car.
Lessor: The finance company or party (sometimes a "captive," which is a finance company wholly owned by a car company) to which a lessee makes payments. The true owner of a leased vehicle.
Mileage Limit/Allowance: The maximum distance a vehicle may be driven during a lease. Any additional mileage will garner an additional fee, usually a per-mile charge. It's always cheaper to buy the excess miles at the beginning of the lease, so it's best to be realistic about your likely mileage needs.
Money Factor: Basically an annual percentage rate for a lease. Expressed as a small decimal figure—say, 0.0025—rather than a percentage rate, but is the same thing as an interest rate: a charge from the lender for using its money. To convert to an equivalent interest rate, just multiply by 24. Money factors will occasionally be expressed as a larger decimal figure, such as 2.5 used to describe 0.0025, which is actually 6%, to disguise them as a low interest rate.
Monroney Sticker: The “window sticker” or price tag on a new vehicle. The sticker placed on a car’s window that lists base price, standard features, optional features and their retail prices, among other information. Invoice price is never listed on the Monroney.
MSRP: Acronym for Manufacturers Suggested Retail Price. This is what's listed for the base price and all options on the Monroney sticker.
Open-End Lease: This is a lease typically only offered to fleets and companies in which the lessee (you) is responsible for the difference between the residual and the fair market value of the vehicle at the close of the lease.
Pre-Computed Interest: A loan in which the total interest is calculated in advance and an equivalent percentage is baked into each monthly payment. If you pay off your principal early, the remainder of these charges should be refunded.
Prepayment Penalties: Charges for paying off a loan early. Because early payment minimizes your total cost of interest, paying off your principal early is usually a good idea. People with good credit and who qualify for good loans shouldn’t have to accept prepayment penalties.
Pre-Qualify: To have a lender confirm you are eligible for a loan without you committing to accepting it.
Principal: The amount borrowed.
Rebate: A partial refund on a new-car purchase offered by the manufacturer or dealership in order to increase sales. Rebates can either be deducted from the purchase price or refunded by mail after the sale has been completed.
Rent Charge: The portion of your lease payment that goes toward financing instead of principal reduction.
Residual Value: The estimated value of a car when it is returned from a lease. In most consumer leases, which are closed-end, this is the value used in the monthly payment calculation and the price at which you can buy the car at the end of a lease.
Sell Rate: The rate at which a dealer offers financing to a consumer. If the dealer has acquired financing at a lower rate (buy rate), it keeps the difference as profit (spread).
Spread: The difference between a dealer's Buy Rate and Sell Rate for financing a loan or lease, typically around one percent. Dealers generally don't disclose this spread, so do your homework on the actual rate being offered by the manufacturer or finance company and negotiate to reduce or eliminate the spread. Also known as a Bump.
Sticker/Asking Price: The price on the Monroney (or window) sticker. Do not pay sticker price. With the exception of brand-new models or those in particularly high demand, cars can typically be bought for a price well below that quoted on the sticker.
Subprime Loans: Loans given to borrowers who represent a particularly high risk to the lender either because of spotty credit or because the vehicle being leased or bought is more expensive than the borrower can reasonably afford. Subprime loans typically include higher interest rates and down payments and end up costing the borrower a lot more.
Term: The length of a lease or loan.
Termination Fee: Can refer to either prepayment penalties or a disposition fee.
Trade-In Value: The price a dealer will pay for your current car when selling you a new one. Dealer trade-in is typically thousands of dollars lower than the price possible with a person-to-person sale, so decide what the convenience of getting rid of your old car at the same time as you get your new one is worth to you.
Up-Front Costs: The total of all costs that must be paid at the signing of the contract: down payment plus any fees.
Upside Down: When you owe more on a loan than your vehicle is worth. This happens because vehicles depreciate rapidly during the first years after they leave the showroom, and is a dangerous situation for several reasons. If you want to trade the vehicle in before your loan balance catches up to the car’s depreciation, you will still owe money to your previous lender in addition to whomever you buy a new car from. Also, if the car is totaled in an accident, the insurance company will only pay you the worth of the vehicle, leaving an outstanding balance with the lender—unless you have gap coverage, which is nearly always worth buying with a new car lease or loan. To minimize the risk of becoming upside down, keep your loan term as short as possible.
Walk-Away Lease: A lease that gives the lessee the option of either buying the car at the end of the term at a set price or walking away without liability for any unexpected reductions in the vehicle's value (other than those resulting from damage or modifications). Walk-away leases are what nearly all car companies and banks offer, but it is smart to verify that your lease is walk-away. Also known as a “closed-end lease.